Understanding Recent Market Volatility

Market volatility and fluctuations can certainly be nerve-wracking. We’re here to help you better understand how the market works, what the fluctuations mean and how to apply them to your circumstances.

First, let’s discuss the history leading up to the drop in the stock market. The new year began with investors feeling very optimistic. Indexes were continuing to rise from 2017, hitting record highs. In January the S&P 500 had its best performance since 1997. On February 1, stocks began dropping. The Dow and the S&P 500 each lost more than 4%. The NASDAQ dropped as well.

However, within a day of the declines, stocks were showing improvements.

So, what happened?

Let’s take a few steps back to gain a wider perspective of what happened. Naturally, when investors watch markets fall, rise or fluctuate they begin wondering what’s going on. What’s causing the fluctuations, especially the ones that are going down?

At first glance, this one appears hard to diagnose. The sell-off in early February had no obvious causes. News about the economy was essentially positive. There was nothing in the news that appeared to have the power to influence the markets so negatively.

What happened in early February appears to have stemmed from emotion-based investing. Investors also overused computer-generated trading, which put in place artificial sell-off points.

Labor reports also showed wages were increasing more than expected, which convinced many investors that inflation rates would rise. Higher wages sometimes means businesses raise prices to pay for higher labor costs.

Worries about inflation and interest rates are only part of the picture. The big issue for investors may be volatility. Volatility is normal.

Consider these facts:

The S&P 500 had undergone an average annual correction of about 14% per year since 1980. 2017, however, was different. Markets were unusually calm, fluctuating only about 3%. Prior to the February market drop, the S&P went more than 400 days without losing more than 5%. That’s the longest time since the 1950s.

Now let’s look at the news. Reports showed the Dow dropping 1,175 points on February 6, the highest decline in history. While that’s a factual statement, it misses a very important detail: percentages. The larger the index, the less significant raw numbers are compared to percentages. 1,175 doesn’t mean the same in an index of 25,000 points compared to one that has 10,000 points. Look at percentages, which provide a more accurate reflection of the market. Not numbers.

Remember this: Yes, the S&P fell 4.1% on February 5. But the next day, it gained 1.7%. If you look at the S&P’s 15 worst days when it lost an average of 8.16%, stocks were still down a day later. But looking at the longer view, in 13 of those cases, stocks were back up 12 months later on average 21%.

Here’s what you need to keep in mind. Even when stocks drop, they eventually turn around and post positive returns.

Let’s go back to the last market correction. In August 2011, the S&P lost 6.66% in one day. Europe was facing a debt crisis. The United States’ AAA credit rating was downgraded. And the financial markets were shaky. Investors were obviously nervous.

The temptation back then was to leave the market. However, staying invested paid off. A year later, the S&P had gained more than 25%.

What can we learn from this recent market fluctuation? Over the short term, markets trade on fear, anxiety, greed, and emotion. Over the long term, sound economic fundamentals drive the market.

The good news?

Indicators show the economy is strong and growing. More than 200,000 jobs were created in January, which was higher than expectations. Average hourly wages rose, which produced 2.9% growth in the previous 12 months. That’s the largest since 2008–2009.

The majority of S&P companies who reported their 4th quarter earnings have surpassed estimates.
In the service industry, the ISM Non-Manufacturing Index hit its highest level since 2005. Personal income and spending by consumers are increasing.

The market fluctuation may have been a difficult lesson. You as investors may still be wondering whether inflation will go up or whether the Fed will raise interest rates. The reality is, market volatility may continue.

Last year’s uncharacteristically calm market may make volatility difficult to get used to. The fact is, the market rarely follows a smooth, straight line.

On a positive note: If this degree of volatility is here to stay, new market opportunities will become available. One economist at First Trust said, “More economic growth will ultimately be a tailwind for equities, not a headwind.”

We encourage you to maintain your focus on long-term goals. Don’t allow emotions to side track you. We want you to be comfortable and confident in your investment decisions.

If your investment objectives have changed, please call us, we’ll be glad to help. We’re here to provide you with clarity, perspective, and support. We appreciate the confidence you place in our abilities and consider it a privilege to be good stewards of the assets you entrust to our care.

Please remember that nothing we talk about here is a recommendation. If you would like to discuss your personal financial situation, please give us a call. We’d be happy to talk to you.

S&P 500 Index is an unmanaged group of securities considered to be representative of the stock market in general. You cannot directly invest in the index. Investing involves risk including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Diversification does not guarantee profit nor is it guaranteed to protect assets. Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance. Past performance does not guarantee future results. You cannot invest directly in an index. Consult your financial professional before making any investment decision. Fixed income investments are subject to various risks including changes in interest rates, credit quality, inflation risk, market valuations, prepayments, corporate events, tax ramifications and other factors. Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance. Drake & Associates does not offer tax or legal advice.